By: Steven M. Roge, CMFC
Our cursory review of the Federal Reserve’s actions this week has us feeling like Operation Twist would be more appropriately named Operation Purple Nurple.
As a kid in the school yard I experienced my fair share of purple nurples and for those who didn’t have the pleasure and aren’t quite sure what it is, a purple nurple is the act of grabbing and twisting another person’s nipple, often leaving it bruised and discolored. The Federal Reserve’s actions have delivered just that to our fragile economy, a thoughtless act that will only send it into a faster tailspin.
Those most affected by this senseless act are the ones most vulnerable to another economic downturn. The U.S. banking system is still recovering from the excesses of our credit bubble over the past two decades. This recovery will likely take a couple more years to work itself out. As many of you know, banks typically borrow short (our deposits) and lend long-term (mortgages). Flattening the yield curve by purchasing longer-dated bonds causes banks to pay more to depositors and will earn less lending as the yield on longer dated bonds plummets.
When will the Federal Reserve realize that the issue isn’t borrowing costs, it’s the access to capital? The federal government’s lawsuit against the big banks isn’t helping either. How are banks supposed to give loans to clients if there is a threat that they will be forced to repurchase billions of dollars worth of loans? The banks simply don’t have the capital to take on those assets. They would need a government bailout via infusion of capital to pay back Fannie (FNMA.OB) and Freddie (FMCC.OB) (i.e. the government).
What kind of world do we live in?
In the Federal Reserve’s perfect little world, pushing down the yield curve even more will entice investors to put their money to work in riskier assets than bonds, which will in turn (theoretically) spur economic growth. A simple example would be that an income-seeking investor would shun government bonds yielding 1% and in turn purchase a dividend-paying stock or a high yielding corporate bond.
However, many yield-hungry investors just doubled up on their fixed income investments to cover the yield they were used to getting. In addition, it pushed many risk-adverse investors into riskier asset classes which they may not have felt comfortable with, in an effort to seek more income to fund their retirement. While we aren’t offering up solutions for the coming economic woes for the global economy, we can make some investment suggestions based on the Federal Reserve’s actions.
First, they just gave investors the pass to invest in long-dated government bonds as this is where the Fed will focus the majority of its bond purchases. We like the PIMCO 25+ Year Zero Coupon U.S. Treasury Index ETF (ZROZ). It provides a better way to hedge portfolios than inverse ETFs such as the ProShares Short S&P500 (SH).
Second, if you must own equities stick with high-quality large cap growth or dividend payers such as Johnson & Johnson (JNJ), Nestlé (NSRGY) and Apple (AAPL).
Third, we can be sure that after this current credit crisis and recession passes that gold bullion will continue to appreciate. Take a look at iShares Gold Trust (IAU) and SPDR’s Gold Shares (GLD). While gold will get hurt temporarily when the dollar rises on days like today, the U.S. government has only one way of avoiding default (since politicians can’t seem to put a sensible business plan together) and that is to devalue to the U.S. dollar.
Maybe the head of the Federal Reserve Ben Bernanke had one too many Purple Nurples growing up. It certainly feels like “Helicopter Ben” is the bully of the school yard and we certainly don’t enjoy him dolling out operation Purple Nurple.
It’s time we landed Ben and his helicopter once and for all.
Disclosure: I am long AAPL, NSRGY.PK, ZROZ, JNJ, GLD.
Additional disclosure: This discussion is for informational purposes and should not be taken as a recommendation to purchase any individual securities. Information within this discussion and investment determination of the author may change due to changes in investment strategy when warranted by changing market conditions, or if a security’s underlying fundamentals or valuation measures change. There is no guarantee that, should market conditions repeat, this security will perform in the same way in the future. There is no guarantee that the opinions expressed herein will be valid beyond the date of this presentation. There can be no assurance that the author will continue to hold this position in companies described herein, and may change any of his position at any time. We use or best efforts to obtain good data in our models, however it can’t be guaranteed that our inputs and data are correct. This is not a recommendation for readers to purchase shares in the above security without consulting your financial professional to discuss your own risk tolerance and objectives.